Even more M&A activity in 2018?

This year has been an impressive year for global stock markets, as some indices reached multi-year highs while others went on to rack up fresh record highs consistently.

The improved economic sentiment and the prospect of even better economic growth triggered a wave of buying in 2017.

Rock bottom rates

Interest rates are at record lows and the cost of borrowing is likely to creep higher next year, giving traders another reason to jump on the buying bandwagon. It is not just investors and dealers who are caught up in the bullish sentiment; companies are too, and we are seeing firms snapping up other organisations, or merging with them to form a more powerful company.

Some M&A deals are funded using debt, and companies are keen to borrow to fund these transactions. 2018 could bring about three or perhaps four interest rate hikes from the US Federal Reserve, and we may even see a rate hike from the Bank of England. The prospect of higher borrowing costs could be attributed to the flurry of M&A deals this year. Negative interest rates in Japan and the eurozone discourages saving, so going down the takeover route using borrowed money might could be seen as an efficient way of expansion.

Consolidation in the sector

The tie up between Paddy Power and Betfair is paying off as synergies are kicking in. The larger pool of clients from different sections of the gambling industry now come under one group – which is beefing up its investment in its technology. The success of the deal presumably prompted Ladbrokes Coral to renew takeover talks with GVC. The merger between Ladbrokes and Coral was completed last year and they clearly have wider ambitions.

The real estate investment trust sector had an interesting start to December. At the start of the month, Hammerson approached Intu with a £3.4 billion offer. If the deal goes ahead it would create the largest commercial property company in the UK. Less than a week later, France’s Unibail-Rodamco declared it will become the world's largest shopping operator when it acquires Westfield for $25 billion.

The commercial property sector is feeling the pinch from online shopping, and the industry reaction has been to grab the most prized real estate assets. If this mentality continues we could see further consolidation in the commercial property market as online retail sales are likely to keep rising.

Pivoting within a sector

Lidl and Aldi have taken a big bite out the UK supermarket sector, and the ‘big four’ of Tesco, Sainsbury's, Morrisons and Asda have suffered for it. In 2016, Sainsbury's acquired Home Retail Group, the owner of Argos, Habitat and Homebase. The deal created one of the biggest food and non-food retail companies in the UK.

Tesco’s takeover of Booker Group was approved in December 2017. The £3.7 billion deal needed approval from the competition and Markets Authority (CMA), as Booker Group acts as a wholesaler to supermarkets and convenience stores, which are in competition with Tesco. The British supermarkets are reacting to the growth of German firms, and in turn they are now altering their positioning in the UK retail space.

Tesco’s acquisition of Booker Group echoes Morrisons deal with McColl’s, whereby Morrisons will act as a wholesaler to the convenience store chain. Morrisons has suffered the most out of the big four supermarkets in the UK, and the McColl’s deal is expected to generate £1 billion in supply sales.

This summer saw Amazon buyout Whole Foods Market for $13.7 billion. It will give the tech giant a footing in the health food sector as well as the bricks and mortar retail business. The online retailer was quick to start selling their products at Whole Food Markets stores, so they could take it in a direction of a general retail shop, like Walmart. Amazon already have some exposure to the UK food retail sector as it offers Morrisons groceries via its Prime Now and Pantry service.

Asset spin-offs

Disney are looking to acquire the bulk of assets owned by 21st Century Fox, and in return Fox would receive a 4.25% share in Disney. Subject to approval, Disney will acquire Fox Studio, and their 30% stake in Hulu, the on-demand service, bringing their stake to 60%, and Fox’s 39% stake in Sky. Disney plan to pull their content from Netflix in 2019, and launch their own streaming service The move will give the Murdochs more time to focus on the ‘news’, as they will retain control of Fox Business and Fox News. Comcast expressed interest in Fox too, as the company was eyeing up some of its assets, and the US Department of Justice blocked the merger between AT&T and Time Warner, so the temperature in the entertainment industry is certainty heating up.

US tax changes

The US is set to vote in favour of tax reforms that would see the corporate tax rate cut from 35% to 21%. The changes to the tax system could lead to US companies repatriating funds back home. We have seen four interest-rate hikes from the Fed in the past year, but interest rates are still at record lows, so expanding via acquisition could be an effective use of capital. Apple have approximately $250 billion overseas, Microsoft hold roughly $130 billion, and Google’s owner has about $60 billion, according to the SEC. Cash rich companies will want to put their money to good use, which could add an extra dimension to M&A activity in 2018.

Caveat emptor

The share price of Carillion crashed this year after the company issued several profit warnings. The construction company took on too many contracts on margins that were too low. Balfour Beatty went through a similar crisis between 2015 and 2016, and Carillion dodged a bullet after they tried to take over Balfour Beatty in 2014. Now Carillion need to take a leaf out of Balfour’s book and turn their business around. Carillion are in dire need of cash, so they could be looking at asset disposals in order to raise funds. When the going is good, companies can be inclined to overstretch themselves and it is crucial to do your homework before putting in a bid.

Too big to bail out

Commerzbank has been in the frame for a merger a few times in the past couple of years, and seeing as the German government owns a 15% stake in the finance house, any potential suitor will need to obtain their approval. In the summer of 2016, it was revealed that Deutsche Bank and Commerzbank held talks about a possible merger, but nothing came of it as both banks realised it would be best to focus on their own restructuring first. Two struggling banks are unlikely to produce one robust one. Besides, the German government are very unlikely to agree to it as they would be worried about the size of a potential bailout.

Italy’s UniCredit and France’s BNP Paribas both recently expressed interest in Commerzebank, but nothing came of it. European banks are clearly contemplating consolidating, but non-performing loans are common across the continent. In the post-sovereign-debt-crisis era, governments will be very cautious about allowing banks to become too big, and the taxpayer may have to come to their rescue.

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